The crisis around Greece and the euro seems to have subsided – for the moment. The European Central Bank has flooded the European financial system with liquidity using the Long-Term Refinancing Operation (LTRO), yet another form of monetary easing. Financial markets seem to be recovering nicely.
Is the LTRO likely to be successful in curing Europe’s crisis? Let me use a corporate analogy: if a company is haemorrhaging financially because it has lost it competitive edge, is flooding the company with liquidity (for example, providing it with easy credit) likely to solve the problem? The liquidity may keep the company alive, but in and of itself, liquidity is not the solution.
The liquidity may only serve to postpone the day of reckoning (e.g. bankruptcy), when the assets of the company are sold to entities that can generate a higher return on them. If, however, the company uses the liquidity to restructure (make its product offering more competitive, whether through research and development, cost cutting, etc.), then the liquidity may serve a constructive purpose.
So what is the evidence: is this massive injection of liquidity to the European economy afforded by the LTRO creating restructuring on a sufficiently massive scale? I will argue that the LTRO is triggering vastly insufficient amounts of restructuring, for at least two reasons.
First, because the LTRO is aimed at banks, not the productive sector. Only banks may take advantage of it. And the evidence shows that even though the banks have benefitted from this infusion of liquidity, the banks themselves have not expanded the credit available to the productive sector.
In fact, in many European countries, banks seem to have dramatically curtailed lending to the corporate sector over the past two or three years.
Second, the banks seem to be relatively relaxed about restructuring themselves. Many of them can make a nice spread on holding government bonds; no need to get their hands dirty trying to work out problem loans or taking risks increasing lending to the business sector.
While I’m not sure statistics are available on the subject, anecdotal evidence from the banks that I have been in touch with is that they generally procrastinate on working out their often massive problem loan portfolios.
Let me approach the question from a different angle: let us envision what should the Greek, Spanish or Portuguese economies look like, if Europe’s strategy for dealing with the Euro crisis were successful?
They should look more like the German economy, with large numbers of companies exporting products and services to places like Asia and America. Until this happens, there will always be massive stresses in Europe, as the so-called "peripheral" countries that are part of the euro zone cannot devalue their currency to create competitiveness.
To be competitive, they must restructure, but restructuring is not happening anywhere near the necessary degree, creating the danger that Europe will remain a "two-track" economy, or worse, will be torn apart.
In 2000, Europe adopted the goals of the Lisbon Agenda: to become the most competitive society on earth. The Nordic countries and Germany restructured massively, and became globally competitive. Germany has become Europe’s export juggernaut.
But outside the Nordic countries and Germany, the Lisbon Agenda lies in tatters. After the great fanfare and failure of the Lisbon agenda, Eurocrats don’t seem to dare to target improvements in competitiveness any more. It is not even on the agenda.
Injecting liquidity into the European financial system without tackling fundamental issues of competitiveness is the equivalent of applying a band-aid to an open wound.
The European Union and member governments need to take aim at the economic crisis with both barrels: liquidity and competitiveness. Competitiveness must return to the agenda.* Les Nemethy is the CEO of Euro-Phoenix Financial Advisors Ltd. (www.europhoenix.com), a Central European corporate finance company focused on mergers and acquisitions. He is the author of Business Exit Planning, published by John Wiley & Sons and available on Amazon.